Good day, ladies and gentlemen, and welcome to the Second Quarter 2012 Hewlett-Packard Earnings Conference Call. My name is Derrick, and I'll be your conference moderator for today's call. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. Rob Binns, Vice President of Investor Relations. Please proceed.

Rob Binns

Good afternoon. Welcome to our second quarter 2012 earnings conference call with Meg Whitman, HP's Chief Executive Officer; and Cathie Lesjak, HP's Chief Financial Officer. Before handing the call over to Meg, may I remind you that this call is being webcast. A replay of the webcast will be made available shortly after the call for approximately 1 year. Some information provided during this call may include forward-looking statements that involve risks, uncertainties and assumptions. If the risks or uncertainties ever materialize or the assumptions prove incorrect, the results of HP may differ materially from those expressed or implied by such forward-looking statements and assumptions. All statements, other than statements of historical facts, are statements that could be deemed forward-looking statements, including, but not limited to, any projections of revenue, margin, expenses, earnings, earnings per share, tax provisions, cash flows, share repurchases, currency exchange rates, the impact of acquisitions or other financial item; any projections of the amount, timing or impact of cost savings, restructuring charges, early retirement programs, workforce reductions or impairment charges; any statements of the plans, strategies and objectives of management for future operations; and any statements concerning the expected development, performance, market share or competitive performance relating to products or services; and any statements or assumptions underlying any of the foregoing.

A discussion of some of these risks, uncertainties and assumptions is set forth in more detail in HP's SEC report, including its most recent Form 10-Q. HP assumes no obligation and does not intend to update any such forward-looking statement. The financial information discussed in connection with this call, including any tax-related items, reflects estimates based on information available at this time and could differ materially from amounts ultimately reported in HP's second quarter Form 10-Q.

Revenue, earnings, operating margins and similar items at the company level are sometimes expressed on a non-GAAP basis and have been adjusted to exclude certain items, including amongst other things, amortization of purchased intangibles, restructuring charges and acquisition-related charges. The comparable GAAP financial information and a reconciliation of non-GAAP amounts to GAAP are included in the tables and in the slide presentation accompanying today's earnings release, both of which are available on HP's Investor Relations webpage at www.hp.com. I'll now turn the call over to Meg.

Margaret C. Whitman

Thank you, Rob, and thanks to all of you for joining us today. The second quarter marks my first 6 months at HP, and I continue to learn about the company every day. It's inspiring. You're surrounded by incredible technology, tremendous innovation, and the people are just terrific. For example, since we last spoke, I participated in TechCon, which is HP's annual internal innovation show. Think of it as the world's greatest science fair for adults, and I was just blown away. The excitement, the enthusiasm, the commitment of HP's technical and innovation community is amazing. From nanoscale-sensing technologies to the memristor, to software that can actually learn, we have an array of forward-looking technologies that are revolutionary. Without question, our innovation engine is alive and well. Now we just need to do a better job of aligning that engine with our businesses in developing a better, faster path to market.

I also recently attended the Drupa conference, which is a show held every 4 years in Düsseldorf, Germany, to showcase the very latest in commercial graphics and printing. And again, I was deeply impressed. It's a chance to see our Color Inkjet Web Press and Indigo portfolio in context. You can see customers and potential customers gravitating towards our innovation. And you clearly can see the shift from analog to digital commercial print happening right before your eyes. The market is being disrupted, and we're leading the charge. I left Drupa with a deeper appreciation for the opportunity HP has to transform that industry.

So now let's talk about HP's performance. Overall, I feel cautiously optimistic coming out of Q2. Our results appear to be stabilizing. While I wouldn't say we turned the corner, we are making progress. For starters, we once again did what we said we were going to do. Our guidance for second quarter non-GAAP diluted EPS was $0.88 to $0.91, and we delivered $0.98, beating the high end of our outlook by $0.07 a share on revenues of $30.7 billion. While earnings and revenues were both down over the prior-year period, the trajectory of the decline began to flatten in Q2, which is encouraging.

Cathie will dig deeper into the numbers and the segment performance in just a few minutes, but let me share a few top-level observations. In PSG, we delivered a solid performance. PSG held margins steady, and an uptick in the commercial business helped offset continued weakness on the consumer side. This contributed to a sequential 6.5% increase in revenue and revenue that was also up slightly year-over-year. With much less impact from the HDD shortage, we executed well and achieved a 2-point sequential gain in worldwide PC market share in calendar Q1. In the process, we reclaimed the #1 share position for commercial globally and we also took the #1 position for commercial in the U.S. from a competitor who’s held the top rank for more than 1 decade. We're absolutely committed to outstanding product design, engineering and quality, attributes that defined HP for decades. You can see that commitment in the big refresh of the PC and printing portfolio we announced in Shanghai a couple of weeks ago. The launch gave us a boost in China, where I think we're starting to regain some momentum. And speaking with customers and partners, I've heard a lot of excitement about the products we introduced, like the Spectre XT, and our new multifunction Color LaserJet Printer. Consumers love the new products and CIOs trust them in a secure work environment. They strike the perfect balance between beautiful design and the workhorse characteristics that businesses and governments require.

In IPG, we improved channel inventory to within an acceptable range. However, we continue to face a weak demand environment, and year-over-year, IPG revenues declined by 10%. Over the last few quarters, IPG has been challenged by external factors such as weak consumer demand and natural disasters, but we're also getting clarity on some of the key actions necessary to continue building on IPG's leadership. We started marketing the quality and innovation of our hardware and supplies, and we're working on new pricing models, services and solutions to further differentiate our offerings.

As you know, in Q2, we announced a strategic realignment that included having the PC and printing businesses join forces under the leadership of Todd Bradley. So far, this is going very well and we see tremendous potential for accelerated growth and efficiencies through common branding, improved marketing, better retail positioning, more attractive product bundles and seamless, best-in-class interoperability.

Turning to Services. Revenues was essentially flat year-over-year in constant currency and we stabilized margins. While margin may fluctuate quarter-to-quarter, we believe that a 10% to 12% range is the right sustainable profit margin profile for Services through the remainder of FY '12. We're focused on building out strategic practice areas in Cloud, security, Information Management and Application Transformation. And we're strengthening the industry alignment of our Services business to help us better solve customer challenges, create more customer value and deepen customer relationships. We're excited about growing these higher-margin categories, but this is a business that continues to be challenged. It's a journey and we have a lot of work ahead of us in this turnaround.

In Enterprise Servers, Storage and Networking, full year revenue declined 6% over the prior-year period. Within that, our Storage and Networking businesses held steady, logging slight annual growth. Storage was a tale of 2 cities. Our 3PAR solutions continued to gain strong traction in the marketplace, growing more than 100% year-over-year, while revenue in our StoreOnce products almost doubled. At the same time, tape and EVA are declining. This is an anticipated product transition and we're effectively managing the shift to our next-generation storage arrays. In Networking, we have a great value proposition and innovation. In one recent development, we worked with AMD on implementing their cloud data center. HP Networking and Server technologies helped reduce the data center footprint by more than 50%, while increasing network capacity and improving performance. And with new solutions like our recently launched virtual application networks, we plan to continue being the disruptor.

In Industry Standard Servers, the HDD shortage was still a factor and we had a tough quarter. However, there's strong promise here. We have some outstanding solutions in the market that we expect to restore the momentum in the category. For example, the launch order ramp for our Gen8 ProLiant server is outpacing that of the Gen7 server. Business Critical Systems, not surprisingly, is still facing challenges from the Oracle Itanium issue, but more important is how we're moving forward. Our Odyssey solution is an innovative, mission-critical x86 platform that will offer customers a transition to open, standards-based architectures.

As part of the Q2 strategic alignment, the global account sales organization joined Enterprise Servers, Storage and Networking under the leadership of Dave Donatelli. This is also going well. The new model sharpens the focus of our sales teams, moves decision making closer to the deal and provides a simplified customer experience. The outcome is a more responsive HP that will make it easier for us to sell effectively and bring more of our portfolio to more of our accounts. In conversations with customers and partners, it's clear that they understand and appreciate the direction we've taken.

In Software, we grew 22% year-over-year, with growth in licenses, support and Services. We had some good wins. For example, in security, we signed a SaaS testing services agreement in Europe that's the biggest deal ever for HP/Fortify. However, we're also facing some challenges. Autonomy had a very disappointing license revenue quarter, with a significant decline year-over-year resulting in a shortfall to our expectations. To help improve Autonomy's performance, Bill Veghte, HP's Chief Strategy Officer and Executive Vice President of HP Software, will step in to lead Autonomy. Mike Lynch, Autonomy's Founder and Executive Vice President for Information Management, will leave HP after a transition period. The market and competitive position for Autonomy remains strong, particularly in Cloud offering, and we have been flooded with a number of big deal leads. Bill is an experienced software leader who will develop the right processes and discipline to scale Autonomy and fulfill its promise, although it will take a few quarters to see tangible improvements.

So big picture, I'd say, that our performance began to stabilize. We saw some bright spots. There's still an awful lot of work to be done and we're looking at every option to accelerate the pace. As discussed during our Q1 call, we are working very hard to better align HP's cost structure with its revenue profile. We're streamlining and removing complexity at every turn, and in the process, we're creating the capacity to invest in innovation and quality. And over time, we're, of course, thinking about how we can drop some of our savings to the bottom line. The strategic realignment we announced last quarter was a good first step, and today, we're taking the next step with the announcement of a multiyear restructuring that will touch every part of HP and create a more streamlined business. We expect to take a pretax charge of approximately $1.7 billion to be included in our FY '12 GAAP results, as well as an additional pretax charge of $1.8 billion to be included in our FY '13 and FY '14 GAAP results. As part of the restructuring, we expect to reduce the workforce by 27,000 positions by the end of 2014, which we'll achieve through a combination of layoffs and a voluntary early retirement program. This restructuring is expected to generate run rate cost savings of approximately $3 billion to $3.5 billion exiting fiscal year 2014. Workforce reductions are never easy. They adversely impact people's lives, but in this case, they're absolutely critical for the long-term health of the company. Our goal is simple: a better outcome for the customers at reduced costs for HP. And while optimizing the workforce is one area that we absolutely need to get right, we see a lot of opportunity in a number of additional areas as well. I know that you're well aware of the cost-reduction efforts that were undertaken in years past. There's been some great work on things like data center consolidation, reducing the number of applications and in horizontal functions such as HR, legal and finance. What we're doing now is very different. We're going after the big cost buckets and fundamental business process re-engineering in our core businesses. This includes optimizing the supply chain, reducing the number of SKUs and platforms, continuing to hone our real estate strategies, simplifying our go-to-market, improving business processes and implementing consistent pricing and promotions to drive end-user demand profitably. It's harder work, but we believe that we'll have a significant payoff over the long term.

Over time, some of the savings will drop to the bottom line, but the majority will be reinvested using a disciplined, data-driven process to prioritize organic opportunities across the business. Return on investment will be evaluated on an ongoing basis and the investments will be calibrated accordingly. We'll be investing to drive leadership in the 3 strategic pillars of Cloud, security and Information Management. And in each of our businesses, we’ll make investments to stay ahead of customer expectations and market trends.

In our PC and printing businesses, we'll be focused on design, engineering, quality and generating demand and desire with our customers. In Services, we're improving processes and building out capabilities in Cloud, security and information. We'll also be strengthening our industry practices, as well as our service quality and innovation. In Software, we'll be investing to speed development across security, information and management infrastructure for both on-premise IT and in the Cloud, with a key focus on Software-as-a-Service offering. This will include the extension of Vertica and Autonomy across our entire portfolio. For example, deploying them in our document workflow solutions and in building out our Information Management practice and services. And in ESSN, we'll invest to drive R&D and innovation in our core businesses of Server, Storage and Networking.

Together, they create a Converged Infrastructure that is the foundation for top customer initiatives, such as Cloud, Big Data analytics and social media. And we'll also invest in our people, in better training and better career development. There's a lot we have to do and we are moving quickly, but we are not taking our eye off the ball when it comes to executing against our ongoing priorities. I'll share just a few examples. In the last quarter, we continued to improve our sales tools with the first wave rollout of our new CRM system and enhancements to hp.com. And in the PC space, a major Mac reseller has taken on the Z1 Workstation, which offers a combination of accelerated performance and design that's not available in any other product on the market today. We also continued to drive our strategy with the announcement of the HP Converged Cloud, the industry's first hybrid delivery approach and portfolio based on a common architecture, spanning traditional IT, private, managed and public clouds.

We announced 10 new products and services to our already extensive Cloud portfolio, and customers are embracing the accelerated innovation, enhanced agility and lower costs that our solutions provide. At HP DISCOVER, we'll be sharing a lot more about our strategy, our portfolio and how we're helping customers succeed. So stay tuned.

I covered a lot today, so let me leave you with a few final thoughts. During our second quarter, we did what we said we were going to do. HP showed some positive, early signs of stabilizing performance. We made progress in a number of areas and delivered on our outlook. We remain confident and expect to achieve non-GAAP earnings per share of at least $4 for FY '12, even before any savings from the restructuring. While the restructuring should improve EPS over time, the pace at which we're able to realize savings and reinvest them is likely to vary quarter-to-quarter, so we don't expect the progress to be completely linear. Things like normal seasonality may not play out exactly the way you're used to seeing it, so our guidance is going to be important. But what matters most, I believe, is that HP is now taking aggressive steps to rebuild and strengthen the company for the long term. I am more confident than ever in our path and in our future. By removing complexity, we're making it easier to do business with HP, easier to sell HP products and easier to work at HP. We're building HP into a more efficient and effective organization that can survive the test of time. And we're creating the capacity to invest, to drive innovation against our strategic pillars of Cloud, security and Information Management, to advance each of our businesses and to ultimately deliver better return for our shareholders. Turning HP around is going to be a lot of hard work. It's going to take time, but we know what needs to be done. And with the actions we've announced today, we're fast-advancing the process. With that, I'd like to turn it over to Cathie to provide more details on the quarter. Cathie?

Catherine A. Lesjak

Thank you, Meg. I'll start with a quick review of the quarterly performance and then give some more details about the restructuring efforts, including expectations for cost savings, headcount reductions, reinvestment and GAAP charges. I'll close with our guidance for Q3 and the second half of fiscal '12.

For the Q2 results. Revenue was $30.7 billion, down 3% year-over-year, both as reported and in constant currency. PSG revenue was flat year-over-year and gained 2 points a share worldwide, quarter-over-quarter, as the business recovered from the hard disk drive shortage triggered by last year's Thailand flooding. ESSN and IPG revenues declined generally as we expected due to the impact of the hard disk drive shortage on ESSN and IPG's continued focus on reducing excess channel inventory.

In terms of our revenue performance by geography, in the Americas, revenue was $13.8 billion, flat year-over-year, both as reported and in constant currency. Revenue in EMEA was down 7% to $10.9 billion and revenue in Asia Pacific was down 1% year-over-year to $6 billion. On a constant-currency basis, EMEA and APJ revenues were down 6% and 3%, respectively, year-over-year. These results reflect the continued macroeconomic challenges in EMEA and some sequential improvement in China.

Non-GAAP gross margin of 23.2% was down 150 basis points year-over-year and up 80 basis points sequentially. Non-GAAP gross margins continue to be impacted by the strong yen, a lower mix of supply, continued margin pressure in services and competitive pricing in our hardware businesses. Non-GAAP operating expenses were $4.4 billion, up 4% year-over-year, driven by acquisitions and our annual salary increases. Non-GAAP operating margin of 8.9% was down 240 basis points year-over-year and the company delivered $1.9 billion in operating profit.

The bridge from operating profit to earnings per share includes the following. Other income and expense yielded a net expense of $243 million, our tax rate was approximately 22% and we used $350 million in the quarter to repurchase 13 million shares, bringing our weighted average share count to 1,987,000,000 shares, which is down 9% year-over-year. As a result, we exceeded our guidance in the quarter, delivering non-GAAP diluted earnings per share of $0.98 and GAAP diluted earnings per share of $0.80. The majority of the difference between GAAP and non-GAAP earnings in Q2 was amortization of purchased intangible assets.

Now turning to our business segments. As Meg highlighted, the Personal Systems Group had strong sequential growth. It delivered revenue of $9.5 billion in the quarter, flat year-over-year, with a 5.5% operating margin. We saw a recovery in desktops and the commercial segment, but consumer notebook demand remained soft. Total units shipped were down 1% year-over-year, but this decline was offset by an increase in the average selling price.

Moving on to Services. Services delivered revenue of $8.8 billion, down 1% from the prior-year quarter and flat in constant currency. Operating profit of $997 million was 11.3% of revenue, down 4.1 points from the prior year, primarily due to the impact of resource management and investments in sales and service delivery. In the second quarter, IT Outsourcing revenue of $3.7 billion was down 3% year-over-year, as we are being more selective in the deals we pursue. New deals need to be a good strategic fit and have attractive margins. Application and Business Services revenue was up 1% year-over-year to $2.5 billion, reflecting the progress we're making in the strategic Enterprise services, including Cloud, Application Modernization and Information Management and analytics. Technology Services revenue was flat year-over-year at $2.6 billion, and up 3% sequentially.

Turning to Imaging and Printing. Net revenue for IPG of $6.1 billion was down 10% year-over-year, with supplies revenue declining 12% as we reduced our channel inventory. We are now within our acceptable ranges for channel inventory on a consolidated basis, but the demand environment remains a headwind. Operating profit was $808 million or 13.2% of revenue, which is down 3.4 points year-over-year. These margins were impacted by the channel corrections, the supplies mix and the strong yen. Drupa, the international print media conference, was a successful event for us in March. We announced 10 new digital printing solutions that demonstrated our leadership in graphics.

By business unit, commercial printer revenue was down 4% year-over-year, with commercial hardware units down 7%. Consumer printer revenue was down 15% year-over-year, with hardware units down 13% and total printer unit shipment volumes was down 11% year-over-year.

Turning to the Enterprise Servers, Storage and Networking business. Revenue of $5.2 billion was down 6% year-over-year, with the majority of the declines due to the hard disk drive shortage. Operating profit was $585 million and the operating margin of 11.2% was 260 basis points lower than the prior-year period. This was due to competitive pricing pressure in Industry Standard Servers and the lower mix of BCS, somewhat offset by the higher mix of Storage and Networking.

Now let's dive into the ESSN performance by business. Storage revenue was up 1% year-over-year, with external disk revenue up 8%. StoreOnce revenue was up almost 100% and 3PAR revenue grew by more than 100%, surpassing EVA in size and making it our largest array business. In fact, combined, EVA and 3PAR grew 19% year-over-year. This growth was somewhat offset by declines in the non-disk businesses, including Tape. Overall, Business Critical Systems revenue declined 23% year-over-year and grew 4% sequentially. Within BCS, our mission-critical x86 revenue grew double digits, but BCS performance continued to be impacted by Itanium revenue decline.

Industry Standard Server revenue declined 6% year-over-year, with almost all of the decline due to the hard disk drive shortage. Again, hard disk drive availability was uneven during the quarter. As supply availability improved, we had less of a mismatch between supply and demand than in Q1, and were able to deliver 4% growth sequentially. Going forward, ESSN should see minimal impact from the hard disk drive shortage.

Networking revenue was up 2% year-over-year at $614 million, or up 4% when normalized for a divestiture in Q1. We continued to expand our presence in the data center segment and sustained double-digit growth year-over-year in Wireless LAN and security. We're confident that we have the right product portfolio, including our recently announced HP Virtual Application Network.

Software delivered revenue growth of 22% year-over-year to $970 million. In the quarter, we saw 7% license growth, 17% support revenue growth and 72% growth in Services. Overall, second quarter operating profit for Software was $172 million or 17.7% of revenue, unfavorably impacted by acquisition-related integration costs and accounting adjustments, as well as a lower mix of license revenue in the quarter. The market and the competitive position for Autonomy remains strong, particularly in Cloud offering and the level of lead generation we are seeing across HP for Autonomy's Software and Services is compelling. But as Meg mentioned, license revenue this quarter was disappointing. Sales execution was a challenge and big deals are taking longer to close.

HP Financial Services continues to deliver strong, consistent results. In the second quarter, financing revenue grew 9% to $968 million. Financing volume was up 5% year-over-year and net portfolio assets increased 4% year-over-year. Operating profit of $96 million was up 16% year-over-year to 9.9% of revenue.

Now onto capital allocation in the balance sheet. Our focus is on rebuilding our balance sheet this year. HP's long-term strategy is to allocate capital where it will generate the best return on that investment. During the quarter, we returned $350 million in cash to shareholders via share repurchases, leaving roughly $9.7 billion remaining in the share repurchase authorization. We also paid $251 million to shareholders in the form of dividends. HP generated $2.5 billion in operating cash flow in the quarter and free cash flow of $1.5 billion.

Our total gross cash at the end of the quarter was $8.7 billion. In terms of working capital, our cash conversion cycle for the second quarter was 28 days, flat sequentially and up 3 days from the prior year. The longer cash to cash cycle from the prior year was due to an increase in inventory by 2 days and a 5-day decrease in days payable outstanding, somewhat offset by a 4-day reduction in days sales outstanding. We have work to do on bringing down our cash conversion cycle and are increasing our focus here.

Now I'll get into the details of our restructuring. Our restructuring efforts will help build the long-term future of HP and is part of the multiyear effort to make HP a simpler, more effective company. We are addressing the trends in our businesses and the market by reducing our cost structure and realigning our workforce to create investment capacity, support growth initiatives and innovation, and enable more effective operations around the world. As part of the restructuring, we expect 9,000 employees to exit the company in fiscal '12 and cumulatively, approximately 27,000 employees to exit the company by the end of fiscal year '14. We are offering an early retirement program in the United States, so the level of nonvoluntary workforce reductions may be impacted by the number of employees that participate in that program. Although notifications will begin shortly, we expect minimal savings impacting Q3, with the majority of the fiscal '12 savings impact in Q4. We expect the restructuring actions associated with the charge to generate annualized savings in the range of $3 billion to $3.5 billion exiting fiscal year '14. To achieve the efficiencies, we will be investing in technology and business processes, as well as doing replacement and enablement hiring for new skill sets, in some cases, in lower cost locations. On top of the cost savings from headcount reductions, we expect further nonlabor savings from SKU rationalization, supply-chain efficiencies and price and promotion strategies. We expect to reinvest the majority of the savings from headcount and non-headcount related actions into our business to foster innovation, particularly in Cloud, Big Data analytics, Information Management and security.

And now onto our earnings outlook. From a macro perspective, we remain cautious about the environment globally for both consumer and commercial spending. Second, we expect the pricing environment to remain competitive. Third, Services margins are expected to remain in the 10% to 12% range for the remainder of fiscal year '12. Fourth, we expect continued decline in Business Critical Systems revenue and the resulting pressure on ESSN margins. Finally, we expect OI&E to be at the low end of the previous guidance, an expense of $1 billion to $1.3 billion for the full year.

With that context, we expect third quarter non-GAAP earnings per share to be between $0.94 and $0.97. If we were to exclude any impact of the restructuring plan we announced today, there would be no change to our previously provided non-GAAP EPS fiscal '12 outlook of at least $4. However, because the restructuring efforts are expected to create savings in Q4 faster than we can reinvest in strategic initiatives, we are increasing our fiscal year outlook to reflect the anticipated benefit in Q4. We now expect non-GAAP fiscal year '12 EPS to be in the range of $4.05 to $4.10.

For GAAP guidance, in fiscal year '12, we expect to take a pretax charge of approximately $1.7 billion for the restructuring effort, of which roughly $1 billion will be in Q3. Through fiscal year '14, we expect to take additional pretax charges totaling approximately $1.8 billion. We expect the cash impact of the restructuring to be approximately $400 million in fiscal '12. Note that we expect to fund much of the cash payments associated with the early retirement program in the U.S. out of the pension plan. In addition, we are evaluating the carrying value of the Compaq trade name, which we acquired 10 years ago. Due to our plan for a more targeted use of the Compaq brand going forward, we expect to record a GAAP-only, noncash impairment charge of up to approximately $1.2 billion in the third fiscal quarter for the write-down in the value of the trade name. Thus, we expect third quarter GAAP earnings per share to be between 0 and $0.03 and full year GAAP earnings per share to be in the range of $2.25 to $2.30.

Now I'll turn it over to the operator for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question is coming from the line of Katy Huberty for Morgan Stanley.

Katy Huberty - Morgan Stanley, Research Division

Cathie, first, a question on free cash flow. The second quarter numbers were quite strong after a weak first quarter. But when you take into consideration the cash cost of the restructuring, where do you expect free cash flow to end this fiscal year relative to non-GAAP income?

Catherine A. Lesjak

So the way to think of -- we haven't been guiding cash flow. The way to think about cash flow over the long term is that cash flow will generally trend in line with our non-GAAP earnings. It is important to understand kind of the cash flow implications for the restructuring charge. In fiscal '12, we expect the cash flow impact to be about $400 million. And then through 2014, we expect the cash flow impact cumulatively to be about $2.7 billion.

Katy Huberty - Morgan Stanley, Research Division

Okay. And then just as a follow-up, do you have a view yet as to whether the share gains in PCs were entirely sellout or were some of that sell-in and channels rebuild after the HDD shortages? And just on the back of that, do you have a view around demand next quarter as the channel and consumers wait for Windows 8?

Margaret C. Whitman

I'll take that. So actually, we saw very good sellout in the channel and we are running at the low end of our desired channel inventory. So we feel pretty good about end-user demand and our ability to pull through that demand with good marketing and great product on the consumer side. And on the Enterprise side, I think we've actually struck that perfect balance between design and the workhorse devices that business and governments need. So we're feeling pretty good about demand.

Operator

Next question is from Bill Shope, Goldman Sachs.

Bill C. Shope - Goldman Sachs Group Inc., Research Division

Okay. Could you give us a little bit more detail on how you're thinking about the secular prospects for IPG, particularly in the consumer segment? And when you parse out this quarter's performance, how much of the supplies decline can we assign specifically to channel inventory reductions? And I guess an extension of that, do you still think we can return to sort of mid-teens margins anytime soon for overall IPG?

Margaret C. Whitman

Let me take the first part of that question, Bill. So listen, in terms of the broad secular trends in this business, what we see at the highest level is an enormous wind at our backs going from analog to digital. There's going to be about 200 billion pages that are going to move from analog to digital over the next number of years. But you're right. In some segments, there is some decline. For example, what we know is people who have home printers are printing less photos in their homes, but we also feel good about the printing in the Enterprise. So here's what we've got to do, and I'll let Cathie answer the question about supplies. As an industry leader, we need to act like one. We need to step up our marketing, we need to take responsibility for growing the category and demonstrating new use cases for printing. We need to get our pricing correct on both our ink, as well as our printers, and we need to make sure we've got the right product at the right time for the right market. In the Enterprise, we missed a cycle on multifunction Color LaserJet, and we now come to market this fall with 8 new multifunction printers in the LaserJet category, which is really going to help us. This is the fastest-growing part of the market that we haven't played in as much as we should have. And then we have to look at the different business models, particularly in emerging geographies. And in emerging geographies, what we found is that you can actually price the printer a little higher, price the print, the ink a little lower and what you end up doing is selling a lot more ink because printing is more affordable to these emerging markets. So we're going to get very aggressive in the printing business. We've got a very clear strategy outlined and I feel very good about the way forward there. It will take a few quarters to, I think, see the results of a more aggressive strategy, but I think we've got this one, so the path forward here is really clear now.

Catherine A. Lesjak

And, Bill, just to address the question on the supplies decline and how much of that was due to channel inventory, the vast majority of the decline was due to channel inventory corrections this year -- I'm sorry this quarter. And we do expect that, obviously, to modulate as we go into Q3 because we ended the quarter within our acceptable ranges on IPG supplies. Now, the caveat I give you is that demand continued to be fairly weak, and so honestly, we would like to take channel inventories down a little bit in Q3, nothing compared to what we were -- we did in Q2, though.

Bill C. Shope - Goldman Sachs Group Inc., Research Division

Okay. And then the question on returning to mid-teens margins over time?

Catherine A. Lesjak

I think you have to go back and dissect, basically, where -- kind of what drove the margins this quarter. So if you actually look at it, there's kind of 3 big drivers of the margins year-over-year for IPG this past quarter. The first one is supplies mix, which was, as we've just addressed, was addressed -- was caused by both channel inventory corrections, which is the biggest impact, but also, we did see some softer demand from a supplies perspective. We also saw, obviously, lower volumes and that put some pressure on operating margins. And then finally, something that we, at this point, are not calling for a change and that's in the strength of the yen. That continues to be a headwind for us in our LaserJet business.

Margaret C. Whitman

I'll make one last comment on that, Bill, as well. Joining forces between the PC business and the printing business, this is going very well. And I think it's actually going to help the printing business a lot in a couple of areas. One is in emerging markets. PSG had a much broader and deeper footprint in emerging markets than IPG, so we're going to leverage that. PSG had a broader account coverage model, direct account coverage model than IPG did, so we're going to leverage that as well. And we have some untapped opportunities in supply chain, nodes, logistics that were not fully exploited because these were different divisions that didn't coordinate as well as they might have. So I think that's another reason where we're going to create some financial capacity, which over time, we'll invest in things that we think make sense and we'll obviously try to improve the margin over time as well.

Operator

Next question is coming from the line of Toni Sacconaghi from Sanford Bernstein.

A.M. Sacconaghi - Sanford C. Bernstein & Co., LLC., Research Division

I know you stated several times that you expected the majority of your restructuring savings to be reinvested. If we take that quite literally and say 40% will actually drop to the bottom line, it's $1.5 billion or $0.60 a share after tax. Is that sort of the right framework that we should be thinking about? And I realize it's exiting 2014, but is that kind of the envisioned balance, given you used the adjective majority?

Margaret C. Whitman

So we are in the process of -- we have a very well-defined outlook, I think, for the savings that we will get through the workforce reductions and early-retirement programs. Cathie said, this is something in my script as well, with $3 billion to $3.5 billion. But you're correct. We are doing a lot of work on supply chain, SKUs and platforms, real estate, go-to-market, pricing and promotions, centralizing advertising and marketing, but we are not to the point yet where we can make a decision about how much of that we want to reinvest in the business because we are now wanting to take a very disciplined approach to say, what is the return on invested capital of an R&D initiative in the Storage business? So what I would recommend, Toni, is listen to our guidance going forward. There will not be perfect linearity in the savings and what we put into investment versus what we drop to the bottom line. So for example, in the fourth quarter, we may get a lot of these savings, but we want to be prudent on investment. But in Q1, we may invest more and bring a little bit less to the bottom line. So I think the best guidance I can give you is we're going to be very disciplined about reinvestment. We're not -- we're going to only reinvest in those opportunities that make financial sense to set up HP for the long term. And this will not be perfectly linear. But we'll -- I think we'll also be able to give you a little more guidance on this at the end of Q3 and the end of Q4.

A.M. Sacconaghi - Sanford C. Bernstein & Co., LLC., Research Division

Okay. Talking about the nonperfect linearity, perhaps you can talk about forces at work on earnings in Q3 and Q4. I think your guidance, even if you strip out the incremental $0.05 to $0.10 from some of your initial savings that have not been reinvested, if we strip that out from the guidance, it still implies a 30-plus percent EPS growth from Q3 to Q4, which is sort of historically unprecedented at HP. Similarly, you're calling for earnings to be lower next quarter, despite not having the tailwind from further significant supplies reduction, not having the tailwind from -- excuse me, the headwind from that and not having the headwind from HDDs. So Cathie or Meg, maybe you can talk about forces at work on EPS that appear to be pushing down EPS in your view in Q3 and then leading to an unseasonably large expectation for EPS growth in Q4, even excluding the anticipated restructuring.

Catherine A. Lesjak

So Toni, actually, I'm a little puzzled by that because the math that we've done and the seasonality that we've looked at is that Q4 seems very much in line with normal seasonality off of Q3. And Q3 -- again pre-restructuring, and Q3 looks roughly in line with what we normally see from Q2. So we're really feeling like this is consistent with normal seasonality.

A.M. Sacconaghi - Sanford C. Bernstein & Co., LLC., Research Division

So you don't expect any sequential benefits or -- I gather, what are the offsetting headwinds, the tailwinds that you should be getting from relief from no supplies channel draw-down and from better availability on the HDD side?

Margaret C. Whitman

Toni, it's Meg again. Let me copter all the way up here because, as I said, overall, we feel cautiously optimistic coming out of Q2, but I wouldn't say yet confidently that we have completely turned the corner. We have made real progress, but we are in the early stages of what we hope to achieve over the next several years. And the headwinds we're facing, I think, in Q3 and Q4 is first of all, Europe. I was just in Europe a couple of weeks ago, and I will tell you, every business leader over there is very concerned with the election of Hollande and what that will mean and what will happen to Greece. We are, as I said, at the early stages of a turnaround in a number of our different businesses. And in my experience, having done a number of these, turnarounds are not linear either. So there may be a setback that we can't anticipate at the moment. And then we're going through a lot of change here. We just joined forces of IPG and PSG, the Global Accounts now report to Dave Donatelli, we have centralized all of our marketing and communications, we've centralized sales ops for the first time under John Hinshaw, and we are undergoing a pretty big restructuring charge and our workforce reduction. So there's a lot of moving parts at HP. I feel confident about our ability to execute against that, but I don't want to get out over my skis in terms of what we tell you we can deliver.

Catherine A. Lesjak

And, Toni, I think you also have to play through a little bit on the currency. Now we are exposed to a huge basket of currencies, obviously, and we do a series of hedging -- different hedges across the different businesses. But at the end of the day, the currency that we're looking at right now is a headwind on a year-over-year basis in Q3 and for full year fiscal '12. On a sequential basis, it's minimal, but on a year-on-year basis, it is still a bit of a headwind from a top line perspective.

Operator

The next question is from Shannon Cross from Cross Research.

Shannon S. Cross - Cross Research LLC

Meg and Cathie, could you provide more color on sort of how you're thinking about the restructuring? I mean, is every business unit going to get sort of a percentage to cut? Does it include any potential divestitures of noncore businesses? And then finally, I'm just curious if you think the back office systems that you have in place right now will allow you to sort of manage through the process, because that's one comment that I've heard from people over time, is that they'd like to see a little bit more sort of on the back office system from an operations perspective.

Margaret C. Whitman

Yes, let me take a crack at that. I mean if you pull all the way back, our restructuring is really about 3 things: we've got to better align HP's cost structure with our revenue portfolio; we've got to position the company to take advantage of some of the biggest shifts that I've seen in technology in my 30-year career in business; and then we've got to streamline our operating model. And so the way we did this is we went business unit by business unit, and by that, I don't mean just at the ESSN level, I mean in Networking and the different projects -- products in Networking to the different PC categories to the different Services businesses that we're in to the different Software products, and basically said, what do we want to focus on? How many individuals do we need to deliver that service? What pieces of those businesses do we want to emphasize versus deemphasize, and came up with a bottoms-up approach to the cost savings that we thought we could achieve from the reduction in workforce, as well as the EERs, and then began to size things like supply chain and go-to-market that we talked about. Then you're right, we have to make some investments in this business, and internal tools and back-office processes are something that we need to invest in. It is not perfect by any means. And one of the steps we took was to combine our sales operations from both our Enterprise business and our consumer business under John Hinshaw, and we're finding lots of opportunities to streamline, to put tools in that will actually make it easier to work at HP. So we've got a lot of work to do in that regard. It is only one bucket of investment that we need to make. But when we do that, boy, I think you're going to see this company hum a lot more efficiently and effectively and be a lot easier place to work for the incredibly dedicated people we have working here.

Shannon S. Cross - Cross Research LLC

Great. And then the second question I have is just on Autonomy. Can you talk a little bit more about the weakness in revenue, and if it changes your outlook on the business at all and how it integrates with HP or is this just something that some different oversight will fix?

Margaret C. Whitman

Yes. So listen, when Autonomy turned in disappointing results, we actually did a fairly deep dive to understand what had happened here. And in my view, this is not the product. Autonomy's a terrific product. It's not the market. There is an enormous demand for Autonomy. It's not the competition. I was wondering, is there a competitor that we didn't see, and the answer to that is no. This is classic entrepreneurial company scaling challenges, and I have seen this movie before. When you try to go from $40 million to $400 million to $1 billion to $2 billion, boy, it takes -- it's a whole different ballgame. And we need to put in some sales ops processes, we need to put in better interface into HP in terms of how Autonomy interfaces with our Services business as well as our Service, Storage and Networking business, and we need a new organizational structure to support a $1 billion-plus company. So we have the people to do this, we have the expertise to do this. Something I'm extremely familiar with, having grown eBay from $4 million in revenues to $8 billion. I really have seen this movie before. And so I feel confident about the long haul, but it may take us a couple of quarters to work through some of the growing pains of the organization. But I think this was a very smart acquisition. I feel great about the product, and we have absolutely hit one of the scenes that is changing most in the Technology business. I mean, the opportunity around Big Data and analytics is fantastic and it can flow right across all of our businesses.

Operator

Your next question is from the line of Brian Marshall from ISI Group.

Brian Marshall - ISI Group Inc., Research Division

If we assume roughly $1 billion of the $3 billion to $3.5 billion savings goes to the bottom line when this is completed in fiscal '14 and the majority of that's going to be going to be going into the new focus areas, obviously Cloud, Big Data, security, is the majority of that $1 billion, would that go towards organic investment, and therefore, probably talking about a pretty sizable increase to the R&D, currently about $3.5 billion is spent annually on R&D. So if that's correct, would assume that we're not looking at any sizable M&A in these 3 areas as well going forward. And then I have a quick follow-up.

Margaret C. Whitman

Yes, Brian. I think that's a fair characterization. We're looking towards organic innovation or organic investment. We don't see any big M&A transactions on the horizon. There may be some tuck-ins, as I've said before, to augment our Software business or maybe some of our other businesses. But I think that's exactly right. This is a -- the heritage at Hewlett-Packard is a fantastic engineering culture, products engineering, service engineering, and the best payback I can see here is to put money into R&D for our engineers to create great services and products and software. So we are going to increase the R&D budget pretty substantially. We're also going to be looking at design and quality because that's another area, I think, that was a hallmark of HP. We need to have the very best quality in the industry across all of our products. And I think we have good quality, but I think we can do better there. We are going to make investments in our people, as I said, in terms of career training -- oh sorry, career development, training. We've got a lot of work to do there as well. And then I think Shannon had called this out. We've got some investment in internal systems that are going to allow us to be a lot faster and nimbler in the marketplace. Cathie, do you want to add anything?

Catherine A. Lesjak

The only thing I want to add is that there are a bunch of numbers thrown out there, and I just want to be clear on what those numbers really mean. So we expect to, as we talked about, to save, on an annualized run rate basis, between $3 billion and $3.5 billion exiting 2014, and it's from that pool of savings that we will look at reinvestment. And at this point, we're not quantifying for you how much drops to the bottom line. Some will definitely drop to the bottom line, but the vast majority will be reinvested back into this business, either in key growth areas where we can grow faster and higher margin categories or back into process reengineering, IT, automation, that will allow us to, frankly, continue to generate savings over the long haul because we're a much more efficient organization.

Brian Marshall - ISI Group Inc., Research Division

Sure. And the quick follow-up is with the extra moneys that are not reinvested in the organization, any change to capital allocation technology [ph] post the completion of the reduction of workforce?

Catherine A. Lesjak

So there's no change in our capital allocation focus, both in the short term or the long term. So on the short term, we've talked a lot about the fact that kind of 2013 -- oh sorry, 2012 and into '13, that our focus is on rebuilding our balance sheet. And we've made progress in Q2 in doing just that because our net debt position improved $1.2 billion, so we're making progress there. Over the long term, the way we think about capital allocation is basically looking at the different opportunities to deploy capital and what types of returns we can get, factoring in both long term and short term because we need some of both, but it's going to be a risk-adjusted returns basis. And frankly, share repurchase has to be on that list of our potential investments as well, because we've got to rack and stack all these investments on an ROIC basis. And so returning cash to shareholders is one of the highest return on invested capital decisions that we make, that we can make, and that's what we'll do.

Operator

Next question is from Keith Bachman from Bank of Montréal.

Keith F. Bachman - BMO Capital Markets U.S.

I had 2 questions, if I could. The first is on Services. You've identified that you want to take out a number of people out of the collective HP, yet at the same time, indicated that there's areas of Services, particularly on the consulting side, that you need to mature and grow. How do you think about the net headcount as you look at Services over that period that you've suggested, say 2 or 3 years? How do you look at the actual change in headcount and trying to provide the consultants and yet at the same time take cost out? And I have a follow-up, please.

Margaret C. Whitman

So we've talked a lot about the fact that Services is a turnaround and that it's going to take 3 to 5 years. And what we're doing is having a transition. We are transitioning our Services business from being heavily weighted to slower-growth, lower-margin portions or services within ITO, and we want to transition this to faster-growing, higher-margin sections related to strategic Enterprise Services -- well, what we consider strategic Enterprise Services, Cloud, security, Information Management and analytics and Application Modernization. And that's going to take us time to make that transition, but that is a big focus here. And at the same time that we're doing that, that obviously has headcount implications, so what we've done is we've basically modeled out that transition over a number of years and the types of skills that we need in order to execute on this transition. And I think it's also important to understand that that's kind of a mix. You can get better margins and services as a result of that mix shift, but it's not just about mix. We're also applying business process reengineering, lean methodologies to our delivery so that we also get a rate benefit on our installed base and obviously, on future contracts that we win.

Keith F. Bachman - BMO Capital Markets U.S.

Well, that's what I was alluding to Cathie, if I could just press on that before I ask my follow-up is, net-net, you need to add people, net-net over the next 2 years in Services, do you see headcount being up, down or flat? In Services?

Margaret C. Whitman

I believe we will have a smaller, more profitable Services business over the next 2 to 5 years, which will have fewer people in it today than it -- fewer people in it tomorrow than it does today because we will have changed mix to businesses but we can make a real -- we have a real differentiation in our offering.

Keith F. Bachman - BMO Capital Markets U.S.

Fair enough, okay. Then let me try -- my follow-on is on the Enterprise side. You've had 2 quarters of non-GAAP margins of about 11.2%. As the G8 and x86 side ramps a little better here with HDDs, would you expect the operating margins to improve over the next few quarters in that division? And that's it for me.

Catherine A. Lesjak

I think if you go back and you look at what drove kind of the declines year-over-year growth this quarter, that's insightful. So we did have lower top line growth that was driven partially due to hard disk drive shortages, which we believe, we are largely through exiting Q2. So minimal impact in the second half from the hard disk drive constraint. But we also saw softer economic demand, I'd say Europe in particular. And that's going to -- we're not calling in our guidance, at least at this point, for a significant improvement in that. We also have seen higher hard disk drive cost, which we expect will also continue through fiscal '12. And then finally, you've got the ongoing headwind from a lower mix from Business Critical Systems that will continue to put pressure on us. Now we've got some -- I would say, some different solutions for customers in that space, but we expect that to continue to put pressure on margins.

Margaret C. Whitman

And also to add one more thing, is that this is an area where, I believe, the return on invested capital and R&D is going to prove to be very high. This is sort of the core of who HP is, is our Server, Storage and Networking business, so we may see some organic improvement of operating margin, which we may choose to reinvest in R&D over the next several years. Because this is an area where, I think, we can be ahead of the curve in both our -- in Server, Storage and Networking, and you can start to see that in our results, I think. I mean even in Industry Standard Servers, which people say to me all the time, well, isn't that a commodity business? Not if we can help it. It shouldn't be. I mean you look at our next generation ProLiant -- Gen8 ProLiant servers, look at Moonshot, look at Odyssey. These are things that redefine that category and that's the kind of the thing we want to invest in.

Rob Binns

I think we've got time for one more question here before we pass to Meg for some closing comments. Operator, one more question, please.

Operator

Your final question is coming from the line of Ben Reitzes from Barclays Capital.

Benjamin A. Reitzes - Barclays Capital, Research Division

Meg, you said something about China in your opening remarks. And I just want to make it clear that you said that the things were turning around there and that was a big headwind for you. And then you -- I just had a quick follow-up on end-demand for PCG, why you're so confident. So I'll ask you 2 at once.

Margaret C. Whitman

Yes, I mean -- again, I don't want to get out over my skis on China because we had a really tough couple of years in China, but it is looking better. There's a 6- or 7-tier distribution system in China, which we're feeling better about. We have a new head of APJ, Dion Weisler, who was in Beijing, who has a tremendous amount of experience. We have spent more time there. I think we are seeing the fruits of our labor in our China Development Center and our China Design Center. So I think we are seeing positive early signs of a stabilization and turnaround. We -- as I said, we announced our new product line in Shanghai for a reason because we wanted to show the commitment to the Chinese government, to the Chinese people for our long-term commitment to the China market. So I feel good about it, but it's early days and, as you know better than most, it's been a tough road for HP and China over the last couple of years.

Catherine A. Lesjak

And those are specific comments to PSG. I guess a couple other bright spots in China, in Industry Standard Server, we had a record quarter in China. So things are looking good there from a Networking perspective. We are continuing to really do well with our H3C products in China. There are bright spots. And then the sequential improvement on the PSG side is a positive direction as well. But to Meg's point, we'll take it kind of one quarter at a time.

Margaret C. Whitman

And we've got a fledgling but growing Services business in China. I’ve met with some of our biggest Services customers there, and actually, I think we have a good opportunity there. On your second question, which was end-user demand for PCs, gosh, everything we see in the marketplace says that there is a demand, there is a refresh coming, potentially around Windows 8. And it appears to be stronger end-user demand, I would say, in Asia and the United States. We still worry about Europe. Europe is one tough place to do business right now and my personal prediction is that this is going to get a little bit softer before it gets stronger, given all the uncertainties around the sovereign debt crisis, around what's going to happen to the Greek debt, about what's going to happen in France and what Germany is going to do to bail everybody out over there.

So, okay. Well, let me just wrap up and sort of end where we began. I mean, overall, we feel cautiously optimistic coming out of Q2. And while I wouldn't say we've turned the corner, we have made real progress. And I think the entire senior leadership team at HP is increasingly confident in the way forward and in our future. So we're excited about continuing to execute over the next several quarters and years.

So thank you very much for tuning in.

Operator

Ladies and gentlemen, this concludes our call for today. We thank you for participating. You may now disconnect.

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